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Credit
Scoring - How it Works
Credit
scoring is a statistical method that lenders use to quickly and
objectively assess the credit risk of a loan applicant. The score is a
number that rates the likelihood you will pay back a loan. Scores range
from 350 (high risk) to 950 (low risk). There are a few types of credit
scores; the most widely used are FICO scores, which were developed by Fair
Isaac & Company, Inc. for each of the credit reporting agencies.
Credit
scores only consider the information contained in your credit profile.
They do not consider your income, savings, down payment amount, or
demographic factors like gender, race, nationality or marital status. Past
delinquencies, derogatory payment behavior, current debt level, length of
credit history, types of credit and number of inquiries are all considered
in credit scores. Your score considers both positive and negative
information in your credit report. Late payments will lower your score,
but establishing or reestablishing a good track record of making payments
on time will raise your score.
Different
portions of your credit file are given different weights. They are:
- 35%
- Previous credit performance (specific to your payment history)
- 30%
- Current level of indebtedness (current balance compared to high
credit)
- 15%
- Time credit has been in use (opening date)
- 15%
- Types of credit available (installment loans, revolving and debit
accounts)
- 5%
- Pursuit of new credit (number of inquiries)
The
most important factor for a good credit score is paying your bills on
time. Even if the debt you owe is a small amount, it is crucial that you
make payments on time. In addition, you may want to: keep balances low on
credit cards and other "revolving credit;" apply for and open
new credit accounts only as needed; and pay off debt rather than moving it
around. Also don't close unused cards as a short term strategy to raise
your score. Owing the same amount but having fewer open accounts may lower
your score.
Recent
changes minimize the negative effects that rate shopping can have on a
mortgage applicant. If there is a consumer originated inquiry within the
past 365 days from mortgage or auto related industries, these inquiries
are ignored for scoring purposes for the first 30 calendar days; then,
multiple inquiries within the next 14 days are counted as one. Each
inquiry will still appear on the credit report.
Every
score is accompanied by a maximum of four reason codes. Reason codes
identify the most significant reason that you did not score higher. The
reason codes can help a lender describe the reasons for higher than
expected rates or loan denial. Scores are not part of the credit profile
and are not covered by the Fair Credit Reporting Act.
Your
credit report must contain at least one account which has been open for
six months or greater, and at least one account that has been updated in
the past six months for you to get a credit score. This ensures that there
is enough information in your report to generate an accurate score. If you
do not meet the minimum criteria for getting a score, you may need to
establish a credit history prior to applying for a mortgage.
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